According to the International Federation of the Phonographic Industry, in 2016 the global music industry grew by 5.9%. Digital revenue accounted for 50% of the global music revenue and digital revenue grew by 17.7%. Streaming revenue grew by 60.4%, which made up for the 7.6% decline in physical revenue and the 20.5% decline in download revenue.
Two players in the digital music world, Spotify – a Swedish behemoth – and Royalty Flow – an affiliate of a small but growing company in Denver, called Royalty Exchange – are both conducting initial public offerings (IPOs). They are very different in size and in the nature of their businesses, but they are inextricably linked to the same trend in the digital music business.
Spotify is set to stream its IPO presentation live on March 15, 2018, and thus bypass the usual roadshow process orchestrated by investment bankers and institutional investors. In doing so, it arguably democratises the offering process and levels the playing field for smaller investors and money managers. It is consistent with the role Spotify has played in shaking up the historical model of music distribution that was controlled by record labels and radio stations.
It risks some market volatility because there is no pre-placement of shares with large institutions and no market stabilisation performed by investment bank underwriters. Spotify, with a valuation already north of $22bn and with no immediate need for cash, evidently believes it is worth the risk.
Royalty Exchange is a small company, based in Denver, whose business is to find, value, acquire and administer media-based intellectual property royalties. Royalty Exchange is the 20% shareholder of a company called Royalty Flow that is currently in the process of a more traditional IPO roadshow to raise capital to finance the acquisition of royalty interests derived from intellectual property created in the media industry.
The immediate use of proceeds for Royalty Flow is the purchase of an interest in a catalogue of work from 1999 through 2013 by Eminem – one of the best-selling music artists of all time. According to the IPO Prospectus, the acquired interest – about 25% of the catalogue – will receive royalty payments based on (i) the number of physical and digital copies sold; (ii) ringtones or other uses, such as downloads of music clips; (iii) the frequency with which the recordings are streamed on services such as Spotify and YouTube; (iv) advertising revenue related to free streaming services; and (v) the number of times songs are synchronised with movies, television shows, advertisements, or video games.
The sale of such interests has a tax benefit for the artist. If the artist holds the interest, the revenue generated is taxed as ordinary income. If the interest is sold, based on IRC Section 1221(b)(3), the income will be treated as gain on sale of a capital asset and will attract a lower rate of taxation.
This benefit was originally intended to be eliminated in the bill passed in December 2018 as the first proposed draft of tax reform by the House of Representatives. The provision was reprieved in the final conference agreement and the exception provided by Section 1221(b)(3) was preserved.
The prospectus describes the approach offered by Royalty Flow as different from that of an artist selling its catalogue to a private equity firm – something that might attract the negative publicity of “selling out”. Instead, Royalty Flow’s offering gives fans an opportunity to purchase an indirect interest in an artist’s catalogue.
Same Business, Different Risk
Whereas Spotify offers investors exposure to the risks of the streaming business, Royalty Flow offers exposure to a stable, proven stream of cash flow. In both cases, the digital world of music offers unprecedented access to data about the dynamics of the business and its underlying economics and helps investors evaluate those risks. Both IPOs are happening soon. Stay tuned.
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